Of Brainwaves and Tsunamis
We thought it might be time to comment on the economic and financial turmoil, not to mention human suffering, that has arisen as a result of the earthquake and tsunami in Japan. The loss of life from this disaster has been enormous and our hearts go out to all those now suffering the impact of this fatal disaster. Feeling the need to do more than just watch, we are also giving money to the Red Cross (www.redcross.org). Many are doing more, as we note that rescue teams from Los Angeles County in California and Fairfax County in Virginia are already on the scene aiding survivors.
But what of the financial and economic impact? What are the markets telling us as they follow their own violent trajectory in recent days?
First of all, markets are doing exactly what they always do, attempting to incorporate the impact of daily events into the price of securities. Attempting to set and reset prices so that they reflect the probable impact on individuals, companies, and economies as a whole. Markets always do this, which is why an examination of daily, weekly, or monthly prices will always show a seemingly random pattern of peaks and valleys. This is because news enters the market randomly and is absorbed as it arrives. In the face of great uncertainty, negative events are usually exaggerated in their impact on security prices. When faced with the unknown, human beings – and that’s all markets are, a collection of human beings – generally assume the worst The economists tell us this is because our utility function includes “risk aversion.” The behavioral finance experts tell us it’s because we give more weight to the prospect of negative outcomes than positive. The neuro-economists, who study financial decisions at the most fundamental level of the brain, tell us it’s because we process negative financial events in the amygdala, where our “fight or flight” responses reside. The bottom line is this: in the short-run, we always assume the worst, and that’s reflected in our security markets.
Of course, fight or flight was the order of the day for our ancestors, when the sabre tooth tiger was their greatest negative event. Modern life calls for a different set of responses, however. This has long been recognized by the more thoughtful investors among us. Baron Rothschild said “you should buy when the cannons are booming and sell when the violins are playing.” Warren Buffet not long ago opined: “you should be greedy when others are frightened and frightened when others are greedy.” Both men, speaking centuries apart, were acknowledging the same thing: we are better served when we act contrary to our natural fears.
Beyond the short-term turmoil working itself out in the financial markets, however, how should we be thinking about recent events if we choose to adopt a long-term perspective? First and foremost, we need to remind ourselves that human beings, as individuals, families, and nations, endure and adapt. If we step back from the peaks and valleys that fill the daily and weekly movements in the stock market, we find that those jagged swings surround an upward trending line. Through all the short-term turmoil that fills the world, human beings – both individually and collectively – adapt and, ultimately, thrive. With no desire to minimize the horror and suffering currently being visited upon the people of Japan, nor make light of the unfolding risks of damaged nuclear reactors, the fact is that the Japanese and the rest of the world will recover and move on. For most of the world, this will be a mere memory a year from now (albeit, a painful one), not a continuing disaster. The world will adapt, Japan will recover, and we will soon find ourselves worrying about something new.
Experts at the Red Cross and elsewhere will tell you that the best time to prepare for an emergency is before it happens. This is true in all things, including our personal finances. As long as we have arranged our affairs so that we have the right types and amounts of insurance, an adequate emergency fund, and a well-diversified portfolio, the events now unfolding in Japan require no financial changes for us. Any impulse to action would best be funneled in a humanitarian direction, with donations to the Red Cross or other disaster recovery organizations. And perhaps also, turning away from the horror still unfolding on our television screens to embrace friends and family and indulge in a moment of thankfulness for the things that truly matter.
With gratitude and respect,
The Yeske Buie Team